The medium of exchange fallacy


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I’m relatively new to the crypto-economics space, so correct me if I’m wrong, but I think that a significant portion of the bitcoin community believes that one of bitcoin’s ultimate targets is to replace fiat money as a medium of exchange or at least to become a mainstream medium of exchange used by billions of people.

It is this particular proposed prospect of bitcoin that troubles me the most, since in my understanding, there is a fundamental reason why bitcoin can never be an efficient medium of exchange. The reason is its deflationary nature.

Economic theory suggests, that the more successful a fixed supply currency becomes, the higher becomes its value. If you possess a unit of "money" that you know it will worth more in the future, you have an incentive not to spend it.

On the other side, producers of goods and services, might not have strong incentives to produce, since it might be more profitable to just hold their bitcoins, instead of spending them in the production process to produce goods and services the price of which will keep decreasing due to deflation effects.

This process tends to decrease the economic activity leading to recession thus constraining human prosperity.

Through this prism I can’t imagine a future in which bitcoin or any deflationary alternative serves as a mainstream medium of exchange. They can very well serve as means of value storing but nothing more.

Imagine a world in which the only currency that exists is a fixed supply token like bitcoin. There is no other currency in circulation. In this case, the entire human wealth will be represented by this fixed supply of money. As people continue to act and produce wealth, the total wealth increases, but the money supply remains fixed, which means that one unit of money represents an ever growing portion of the wealth. As an example, while a year ago you could buy one car with one coin, now you can buy two cars with one coin (the price of the car is half what it was the year before). This price deflationary situation leads to the before mentioned economic problems.

This leads to the conclusion that new money creation (money supply inflation) is a necessary feature of any efficient mainstream medium of exchange. Bitcoin at its current form is a fixed supply token, thus it can’t take that role.

Is this issue something that is discussed within the bitcoin community? Or is it a consensus that bitcoin will only serve as store of value if it succeeds to become mainstream? It would be very interesting to know your thoughts on this.

submitted by /u/dimyG
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